The Joint & Several Liquidators of China Medical Technologies, Inc. v. Kpmg (A Firm) and Others

CACV 65/2017

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 65 OF 2017

(ON APPEAL FROM HCCW NO 435 of 2012)

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JUDGMENT

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Hon Lam VP (giving the Judgment of the Court):

1.The liquidators of China Medical Technologies Inc [“the Liquidators”] sought an order under Section 221 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance Cap 32 to have access to documents in the possession of the former auditor of the company, KPMG (which was referred to in the judgment of the judge as KPMG HK, to distinguish it from KPMG Huazhen). The application was opposed by KPMG on the ground that some documents were in the possession of its associated firm KPMG Huazhen in Mainland China and subject to the regime of the Mainland regulating disclosure of audit work papers. KPMG said the release of such documents to the Liquidators could occasion sanctions against KPMG Huazhen [REDACTED].

2.The history and background to this application are fully set out in the judgments of Harris J of 24 February 2016, 3 June 2016 and 12 January 2017.  As the parties are familiar with the same and given the obvious (and understandable) concern [REDACTED] on confidentiality, as there is a possibility that the judgment of this Court is to be published (though at the moment we have embargoed the publication of this judgment) we would confine ourselves to the bare essentials on factual information in this judgment.  

3.Harris J granted the application and made a series of orders. 

4.On 24 February 2016 (the hearing took place in early October 2015, before a review of the documents by an independent PRC law firm), the learned judge ordered KPMG to produce to the Liquidators the relevant documents with a special provision under enabling KPMG to apply to court for variation of the order “in the event of any matter occurring subsequent to [the order] which in the view of [KPMG] inhibits or prevents them from complying with any part of the order”. 

5.On 26 April 2016, KPMG took out a summons seeking variations of the order.  For present purposes, it is sufficient to set out the variation sought under paragraph 1 as follows:

“a)  Insofar as the aforesaid Documents or copies of them are located in the Mainland or stored in a form which only allows them, as at 24 February 2016, to be accessed in the Mainland, the 1^st Respondent shall give the Liquidators access to the Documents, at KPMG Huazhen's office in Beijing on the following basis:

i) The fact that the Liquidators have been permitted access to the Documents in Beijing shall remain confidential;

ii) Documents assessed by KPMG Huazhen's external PRC Counsel to contain information which amounts to a state secret or is otherwise sensitive and whose passing to an overseas institution or individual would be prohibited by Article 6 of the PRC's Provisions on Strengthening Confidentiality and Archives Administration of Overseas Issuance and Listing of Securities of 2009 shall be redacted prior to access being provided to the Liquidators;

iii) Staff from KPMG Huazhen and from their external PRC counsel shall be present when access to the Documents is provided to the Liquidators;

iv) No copies of the Documents may be made by the Liquidators; and

v) The Documents must not be removed by the Liquidators from KPMG Huazhen's premises in Beijing.

b)  The Liquidators shall be provided with access to the Documents in the PRC within 35 days or such other date that the parties agree or the Court directs.”

6.[REDACTED]

7.By the time of the hearing of the summons for variation before the judge on 3 June 2016, it was accepted by the parties that there was no more concern about state secrets being contained in the documents in question as there had been a vetting of the same by a PRC law firm which had completed a review in mid-January 2016.  The law firm identified approximately 50 passages in the documents which contained “sensitive information”. 

8.In the judgment of 3 June 2016, the judge drew a distinction between audit working papers and other documents.  In respect of the former, the judge held that there was no basis to ask for any variation.  In respect of the latter, the judge adjourned the variation application with leave to the parties to file further evidence. 

9.On 1 August 2016, the Liquidators issued a summons seeking variation of paragraph 3 making provisions for redaction of sensitive information and the following directions at paragraphs 2 to 6 of the summons:

“ Provision for Sensitive Information

2.  Within 21 days, the 1^st Respondent shall cause for such application to be made as is required under the laws of the People's Republic of China to determine whether any of the Sensitive Information is a state secret and to have any state secrets marked as such by the appropriate authority.

3.  Within 21 days of any of the documents referred to in paragraph 2 hereof being determined by the relevant authority as containing state secrets, the 1^st Respondent shall cause such application to be made as is required under the laws of the People's Republic of China for authorisation to produce copies of the relevant documents to the Liquidators.

4.  Within 7 days of (a) determination that any Sensitive Information is not a state secret or (b) authorisation being granted by the relevant authority to produce documents containing state secrets to the Liquidators; the 1^st Respondent shall produce copies of the relevant documents to the Liquidators in Hong Kong, and make the original documents available to the Liquidators for inspection upon request in accordance with paragraph 4 of the February Order.

5.  The 1^st Respondent is to keep the Court and the Liquidators appraised of the status of its actions pursuant to paragraphs 2 and 3 hereof by filing evidence within 7 days of each month end, exhibiting thereto all correspondence and notes or memoranda of conversations with the relevant authorities, until such time as all Sensitive Information has been classified and the relevant authority has determined whether to authorise production of copies of the documents containing state secrets to the Liquidators.

6.  The 1^st Respondent and its agents and legal advisers shall maintain in written form a complete and accurate record of all communications concerning the steps taken in compliance with paragraphs 2 and 3, including contemporaneous file notes of conversations and copies of all written communications, hereof between (a) the Respondents themselves, their employees and agents or (b) between the Respondents, their employees and agents or their legal advisors on the one part and third parties on the other part.”

10.The matter was heard by Harris J on 15 September 2016.  On 12 January 2017, the judge made an order [“the January Order”] in these terms:

“ 2.  Paragraph 3 of the February Order is varied to replace its terms as follows with effect on and from the date of this Order:

3.  Insofar as the Documents referred to in paragraph 1 of the February Order or copies thereof are located in the Mainland or stored in a form which allows them, as at 24 February 2016, to be accessed only in the Mainland:

(1)  the 1^st Respondent shall within 35 clear calendar days produce copies of the Documents to the Liquidators in the Mainland after redacting the information identified by Zhong Lun Law Firm as “sensitive information”.

(2)  the Liquidators shall retain, maintain and keep safe the copies of the Documents provided to the Liquidators any further copies whether in physical or digital form taken by the Liquidators in the Mainland until further order;

(3)  the 1^st Respondent shall within 21 clear calendar days cause such application as is required and alternatively permitted and alternatively possible under the Laws of the People's Republic of China to be made for a determination as to whether or not there is any restriction under the Laws of the People's Republic of China on copies of the aforesaid documents without redactions being provided to the Liquidators, alternatively the aforesaid documents without redactions being made available for inspection by the Liquidators;

(4)  the 1^st Respondent shall, in the event that it is determined that copies of the aforesaid documents without redactions may be provided to the Liquidators or inspected by them, provide copies or allow inspection as the case may be within 14 clear calendar days of the Respondents receiving notification of the relevant determination;

(5)  the 1^st Respondent shall maintain a written record of any application or applications made pursuant to sub-paragraph 3 hereof including hearings, meetings or telephone conversations;

(6)  [REDACTED]

(7)  [REDACTED]

(8)  there be general liberty to apply.”

11.KPMG unsuccessfully sought leave to appeal before the judge on 10 February 2017.  Leave was subsequently granted by Lam VP and Barma JA on 3 March 2017 with an interim stay.  Directions were given for the hearing of the appeal on urgent basis.  The appeal was heard by us on 3 April 2017. 

12.There is no dispute as to the applicable law in relation to a Section 221 application.  In the judgment of 24 February 2016, the judge discussed the legal principles at [42] to [43] citing extensively from the relevant paragraphs in the judgment of Lord Millett in Kong Wah Holdings Ltd v Grande Holdings Ltd (2006) 9 HKCFAR 766, [23] to [30].  It is an exercise of discretion balancing the liquidator’s reasonable requirements against the need to avoid making an order that is unreasonable, unnecessary or oppressive to the party from whom the documents are sought.  For our purposes, we only need to recite the summary of the principles governing the balancing exercise at [30] of Lord Millett’s judgment:

“ (1)  The liquidator must show that the documents are reasonably required to enable him to carry out his functions, not that they are necessary to enable him to do so;

(2)  The case for making an order under the section in respect of a former officer is usually stronger than in respect of a stranger who owes no fiduciary duties to the company and who is not under a statutory duty to assist the liquidator;

(3)  There is an element of oppression in requiring a party to provide information which exposes him to potential liability;

(4)  An order for oral examination is likely to be more oppressive than an order to produce documents;

(5)  It is oppressive to require a person suspected of wrongdoing to prove the case against himself on oath prior to proceedings being brought;

(6)  An order is not necessarily oppressive because it is inconvenient for the party subject to it or causes him a lot of work or may make him vulnerable to future claims;

(7)  In the light of the summary nature of the procedure and the need for expedition, the court cannot be expected to indulge in fine judgments as to the precise width of the order which should be made; and

(8)  The court must take care not to cut down the width of the order sought by the liquidator in a way which would risk making it ineffective.”

13.The judge was satisfied that the Liquidators reasonably required the documents for the reasons canvassed at [44] to [48] of the judgment of 24 February 2016.  This is not challenged in this appeal.  Based on the submissions before us, we are more concerned with propositions (3) and (6) to (8) in this appeal.  In a nutshell, KPMG’s case is that it is oppressive to grant the order for production of copies as it would expose KPMG Huazhen to potential sanction [REDACTED]. 

14.In this connection, at [54] of the judgment of 24 February 2016 the judge referred to the judgment of Chadwick LJ in Re Mid East Trading Inc [1998] 1 BCLC 240.  It is also an authority on which Mr Coleman SC placed some reliance before us.  The relevant part of that judgment is reported at p.257b to c:

“ In applying that test --- and, in particular, in considering what burden would be imposed on [the party required to produce documents] --- the court will, of course, give weight to any risk that compliance with the order would or might expose [that person] to claim for breach of confidence, or to criminal penalties, in the jurisdiction in which the documents are. Where that is a real risk, it seems to us likely that the Companies Court will be slow to order production; at least if there is some other route by which the documents can be obtained which affords protection to [the person producing documents]. But that is because the risk that [the person] will be exposed to liability is a factor --- albeit an important factor --- to be weighed with others; and not because there is some special hurdle of ‘exceptional circumstances’ to be overcome by the applicant.”

15.In our judgment, the real issue in this appeal is about the application of the approach set out in Re Mid East Trading, supra, to the facts of the present case.

16.Before we address the submissions of counsel, we would refer to some latest developments as set out in the 2^nd Affirmation of Len Jui of 7 March 2017.  Though the admission of this affirmation is objected to by Ms Chan SC on behalf of the Liquidators, we are of the view that as we are dealing with a matter which engages interactions with an authority not within Hong Kong and continuous developments in the liaison with such authority [REDACTED] is envisaged by the orders of Harris J, it is proper and right that this Court should be provided with up-dated information as to the progress in that regard.  In coming to that conclusion, we bear in mind the stricture against admission of evidence of new events in an appeal as discussed in TL v SN [2010] HKFLR 506 and PW v PPTW [2015] 1 HKC 450.  However, the present situation is wholly different and, as we said, the orders of Harris J themselves make provisions for KPMG to apply to court in the event of further developments [REDACTED].  Hence, the whole matter is subject to on-going reviews, without which the whole process could not bear fruit.  In these circumstances, we accept it is appropriate for this Court to admit the evidence on up-dated developments.

17.For reasons which shall become apparent below, we do not see any need to have evidence in response from the Liquidators for the disposal of this appeal.  Hence, we decline to accept the course of remitting the matter to the court below as proposed by Ms Chan. 

18.[REDACTED].  Having considered the evidence in light of the submissions of counsel, it seems to us that a major difficulty for the resolution of the conundrum lies in the absence of any official protocol or memorandum of understanding between the authorities in the Mainland and those in Hong Kong for handling a situation like this.  [REDACTED].  Given the great number of cross-border activities conducted by companies carrying on business in Hong Kong and cases involved cross-border insolvency issues, there is indeed a pressing need for an appropriate protocol or some form of memorandum of understanding to be in place.  As far as we are aware, there are still works to be done in that direction. 

19.[REDACTED]

20.[REDACTED]

21.[REDACTED]

22.The relevant laws and regulations are Regulation 29 (Provisions of China Securities Regulatory Commission, State Secrecy Bureau and State Archives Administration on Strengthening Confidentiality and Archives Administration on Overseas Issuance and Listing of Securities) discussed by Harris J at [59] to [61] of the judgment of 24 February 2016, Art 22 of a “Plan for Localised Transformation of Chinese-Foreign Cooperative Accounting Firms” discussed at [63] to [64] and Art 12 of “Interim Provision on the Audit Services Provided by Accounting Firms for the Overseas Listing of Mainland Chinese Enterprises” discussed at [68] and [69] of the judgment.

23.By now, it is fairly accepted by Mr Coleman that there would not be any concern regarding state secrets in light of the outcome of the review by the PRC law firm.  Further, even for “sensitive information”, given the provision for redaction of the same under the January Order, there is no real risk regarding dissemination of the same to the Liquidators.  Thus, there is no real risk of KPMG or KPMG Huazhen acting in breach of Regulation 29 or other duty to observe confidentiality regulations as referred to in Art 22 or Art 12.

24.In terms of keeping of audit papers within the Mainland, there is no question of the originals of the audit papers being given to the Liquidators.  In respect of copies to be supplied, the new paragraph 3(2) as varied under paragraph 2 of the January Order obliges the Liquidators to keep the copies within the Mainland. 

25.Thus, we do not see any risk of non-compliance with any written laws or regulations in the Mainland if KPMG Huazhen were to act in accordance with the January Order.

26.Mr Coleman submitted that irrespective of our views on the Mainland regulations there is still a risk [REDACTED].  Counsel stressed that it is not for this Court to decide how the laws are to be interpreted or administered in the Mainland.  [REDACTED]  

27.In his written submissions, Mr Coleman submitted that Harris J erred in the exercise of the discretion as he failed to recognize the unequal importance of the risk of sanctions [REDACTED] and the convenience to the Liquidators in getting copies instead of carrying on with inspection at the office of KPMG Huazhen.  He said the former factor is of much greater significance than the latter.

28.[REDACTED]

29.Relying on the judgment in Re Mid-East Trading Ltd, supra, Mr Coleman submitted that as there is another route for access of the documents being given to the Liquidators, the court should be slow to order production which carries with it a real risk of KPMG Huazhen being visited with sanctions.

30.On behalf of the Liquidators, Ms Chan submitted that this Court should not interfere with the exercise of discretion by Harris J.  She submitted KPMG had failed to discharge the burden of showing that there was any real risk of KPMG Huazhen being exposed to serious sanctions [REDACTED]. 

31.Ms Chan did not accept the characterization of the two factors in the balance put forward by Mr Coleman.  She submitted the judge was correct in assessing whether there was a real or exaggerated risk of serious sanction and found that the risk [REDACTED] was doubtful. 

32.In her oral submissions, Ms Chan further disputed Mr Coleman’s description of the Liquidators obtaining copies of the documents as a mere matter of convenience.  In that connection, counsel took us to part of the evidence in the 4^th Affirmation of Mr Borrelli, in particular paragraphs 34 to 40.

33.In our judgment, notwithstanding the assertions of KPMG the court must carry out an independent assessment of the risk of sanction [REDACTED]. If there is no real risk, the need of the Liquidators to have meaningful and effective access to the documents in carrying out their functions as liquidators must prevail.  This is exactly what Harris J did in his judgment of 12 January 2017 and he came to the conclusion that the alleged risk is doubtful.

34.[REDACTED] [T]he judge was comparing the picture KPMG painted before him at the hearing in October 2015 and the real situation as emerged in evidence filed subsequently.  Viewed in that light, we do not accept Mr Coleman’s submission that the judge had misunderstood the situation. 

35.The judge did not have the benefit of the latest evidence as we did.  Even taking such evidence into account, we come to same conclusion as the judge: as the evidence stands, there is no real risk of [REDACTED] serious sanctions against KPMG or KPMG Huazhen for complying with the January Order. 

36.[REDACTED]

37.As invited by Mr Coleman, we read these letters in the context of the oral discussions between the parties.  [REDACTED] we do not accept that those intimations would have the force of law or regulatory directives to back up any sanctions against KPMG in case of non-compliance. 

38.In this connection, we have not lost sight of the evidence of Mr Wagner on soft law or directives in the PRC.  However, with due respect, we find the evidence of Professor Yao to be more persuasive.  [REDACTED]

39.[REDACTED] 

40.In that respect, it may be helpful for us to state that the Liquidators are subject to the supervision of the court in Hong Kong as they are actually officers of the court.  Without the permission of the court in Hong Kong, the removal of the documents out of the Mainland by the Liquidators would be a contempt and we cannot imagine any circumstances under which the Liquidators would do so. 

41.Further, in the exercise of its power in respect of the Liquidators, the court in Hong Kong will give due regard to the concerns of the [REDACTED] authorities in the Mainland as to the control and use of documents, bearing in mind that they are the state regulators in their respective fields in the Mainland. Thus, concerning disclosure of documents situated in the Mainland, the Hong Kong court must respect their roles and their exercise of regulatory powers.  As mentioned in the course of the hearing, [REDACTED] the court will give due consideration to the same when they are raised and to that end impose conditions on the use and disposal of documents by the Liquidators if it is appropriate to do so. In our judgment, an approach of mutual respect and understanding is important as we should recognize that effective tackling of cross-border insolvency issues demands co-operation between those exercising powers in different jurisdictions. The practice of the court in Hong Kong making mirror orders (as discussed in Hong Kong Civil Procedure 2017 para 121/0/5C) to foster co-operation between authorities in different jurisdictions in cross-border matters (albeit in another context) can be modified and adopted in the present context pending a formal protocol or arrangement coming into place.

42.As we have already said, there is no risk of sensitive information getting into the hands of the Liquidators since such information would be redacted from the copies to be provided. 

43.[REDACTED] [W]e are not satisfied the judge erred in concluding that there is no real risk of serious sanction [REDACTED] against KPMG or KPMG Huazhen for complying with the January order. 

44.In any event, paragraph 5 of the order made on 24 February 2016 is still in place.  Reading that together with sub-paragraph (8) of paragraph 3 as varied under paragraph 2 of the order of 12 January 2017, KPMG is at liberty to come back to court in case further developments substantially increase the risk of sanction as inhibiting or preventing them from complying with the January Order.

45.As regards the need of the Liquidators to have copies of the documents, we agree with the submissions of Ms Chan that the existing mode of inspection (implemented since 17 May 2016) is not wholly effective and there is a real need to order production of copies.

46.We therefore do not accept Mr Coleman’s submission that the judge had erred in the application of Re Mid-East Trading Ltd, supra on the facts of the present case.  We do not agree that the judge did not have proper regard to the relevant factors.  There is no valid ground for us to interfere with the judge’s exercise of discretion.

47.However, [REDACTED] we would grant an extension of 35 days from the date of the handing down of this judgment to KPMG to comply with paragraphs 3(1) and (3) as varied.

48.Subject to that extension, we shall dismiss the appeal and order KPMG to pay the costs of the Liquidators in this appeal, such costs to be taxed if not agreed. 

Ms Linda Chan SC and Mr Jason Karas, solicitor advocate, instructed by Lipman Karas, for the applicants

Mr Russell Coleman SC and Mr Wilson Leung, instructed by Smyth & Co in association with RPC, for the respondents